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SENSEX - THE BAROMETER OF INDIAN CAPITAL MARKETS

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SENSEX - THE BAROMETER OF INDIAN CAPITAL MARKETS
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vishal1986
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SENSEX - THE BAROMETER OF INDIAN CAPITAL MARKETS - August 23rd, 2005

Introduction

For the premier Stock Exchange that pioneered the stock broking activity in India, 128 years of experience seems to be a proud milestone. A lot has changed since 1875 when 318 persons became members of what today is called "The Stock Exchange, Mumbai" by paying a princely amount of Re1.
Since then, the country's capital markets have passed through both good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no scale to measure the ups and downs in the Indian stock market. The Stock Exchange, Mumbai (BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market.

SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. First compiled in 1986, SENSEX is a basket of 30 constituent stocks representing a sample of large, liquid and representative companies. The base year of SENSEX is 1978-79 and the base value is 100. The index is widely reported in both domestic and international markets through print as well as electronic media.
The Index was initially calculated based on the "Full Market Capitalization" methodology but was shifted to the free-float methodology with effect from September 1, 2003. The "Free-float Market Capitalization" methodology of index construction is regarded as an industry best practice globally. All major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the Free-float methodology.
Due to is wide acceptance amongst the Indian investors; SENSEX is regarded to be the pulse of the Indian stock market. As the oldest index in the country, it provides the time series data over a fairly long period of time (From 1979 onwards). Small wonder, the SENSEX has over the years become one of the most prominent brands in the country.
The growth of equity markets in India has been phenomenal in the decade gone by. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. The SENSEX captured all these events in the most judicial manner. One can identify the booms and busts of the Indian stock market through SENSEX.


SENSEX Calculation Methodology

SENSEX is calculated using the "Free-float Market Capitalization" methodology. As per this methodology, the level of index at any point of time reflects the Free-float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization.

The base period of SENSEX is 1978-79 and the base value is 100 index points. This is often indicated by the notation 1978-79=100. The calculation of SENSEX involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time.


Understanding Free-float Methodology

Concept:
Free-float Methodology refers to an index construction methodology that takes into consideration only the free-float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in Index. Free-float market capitalization is defined as that proportion of total shares issued by the company that are readily available for trading in the market. It generally excludes promoters' holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course. In other words, the market capitalization of each company in a Free-float index is reduced to the extent of its readily available shares in the market.
In India, BSE pioneered the concept of Free-float by launching BSE TECk in July 2001 and BANKEX in June 2003. While BSE TECk Index is a TMT benchmark, BANKEX is positioned as a benchmark for the banking sector stocks. SENSEX becomes the third index in India to be based on the globally accepted Free-float Methodology.


Major advantages of Free-float Methodology:
A Free-float index reflects the market trends more rationally as it takes into consideration only those shares that are available for trading in the market.

Free-float Methodology makes the index more broad-based by reducing the concentration of top few companies in Index. For example, the concentration of top five companies in SENSEX has fallen under the free-float scenario thereby making the SENSEX more diversified and broad-based.

A Free-float index aids both active and passive investing styles. It aids active managers by enabling them to benchmark their fund returns vis-Ă*-vis an investable index. This enables an apple-to-apple comparison thereby facilitating better evaluation of performance of active managers. Being a perfectly replicable portfolio of stocks, a Free-float adjusted index is best suited for the passive managers as it enables them to track the index with the least tracking error.



Maintenance of SENSEX
One of the important aspects of maintaining continuity with the past is to update the base year average. The base year value adjustment ensures that replacement of stocks in Index, additional issue of capital and other corporate announcements like 'rights issue' etc. do not destroy the historical value of the index. The beauty of maintenance lies in the fact that adjustments for corporate actions in the Index should not per se affect the index values.
The Index Cell of the exchange does the day-to-day maintenance of the index within the broad index policy framework set by the Index Committee. The Index Cell ensures that SENSEX and all the other BSE indices maintain their benchmark properties by striking a delicate balance between frequent replacements in index and maintaining its historical continuity. The Index Committee of the Exchange comprises of experts on capital markets from all major market segments. They include Academicians, Fund-managers from leading Mutual Funds, Finance-Journalists, Market Participants, Independent Governing Board members, and Exchange administration.


On-Line Computation of the Index:
During market hours, prices of the index scrips, at which trades are executed, are automatically used by the trading computer to calculate the SENSEX every 15 seconds and continuously updated on all trading workstations connected to the BSE trading computer in real time.


Adjustment for Bonus, Rights and Newly issued Capital:
The arithmetic calculation involved in calculating SENSEX is simple, but problem arises when one of the component stocks pays a bonus or issues rights shares. If no adjustments were made, a discontinuity would arise between the current value of the index and its previous value despite the non-occurrence of any economic activity of substance. At the Index Cell of the Exchange, the base value is adjusted, which is used to alter market capitalization of the component stocks to arrive at the SENSEX value.
The Index Cell of the Exchange keeps a close watch on the events that might affect the index on a regular basis and carries out daily maintenance of all the 14 Indices.


Adjustments for Rights Issues:
When a company, included in the compilation of the index, issues right shares, the free-float market capitalisation of that company is increased by the number of additional shares issued based on the theoretical (ex-right) price. An offsetting or proportionate adjustment is then made to the Base Market Capitalisation (see 'Base Market Capitalisation Adjustment' below).


Adjustments for Bonus Issue:
When a company, included in the compilation of the index, issues bonus shares, the market capitalisation of that company does not undergo any change. Therefore, there is no change in the Base Market Capitalisation, only the 'number of shares' in the formula is updated.


Other Issues:
Base Market Capitalisation Adjustment is required when new shares are issued by way of conversion of debentures, mergers, spin-offs etc. or when equity is reduced by way of buy-back of shares, corporate restructuring etc.


Base Market Capitalisation Adjustment:
The formula for adjusting the Base Market Capitalisation is as follows:

New Market Capitalisation
New Base Market Capitalisation = Old Base Market Capitalisation x ---------------------------------------
Old Market Capitalisation

To illustrate, suppose a company issues right shares which increases the market capitalisation of the shares of that company by say, Rs.100 crores. The existing Base Market Capitalisation (Old Base Market Capitalisation), say, is Rs.2450 crores and the aggregate market capitalisation of all the shares included in the index before the right issue is made is, say Rs.4781 crores. The "New Base Market Capitalisation " will then be:

2450 x (4781+100)
-------------------------- = Rs.2501.24 crores
4781

This figure of 2501.24 will be used as the Base Market Capitalisation for calculating the index number from then onwards till the next base change becomes necessary.
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Re: SENSEX - THE BAROMETER OF INDIAN CAPITAL MARKETS
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Re: SENSEX - THE BAROMETER OF INDIAN CAPITAL MARKETS - July 2nd, 2006

Thanks for info,

U r doing Great job.
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Re: SENSEX - THE BAROMETER OF INDIAN CAPITAL MARKETS - September 25th, 2014

With this update we need to update our-self with daily market news, what happening in the stock market. Like, recently Indian PM going to US visit, so what effect we can see on the stock market, I read here MMFSolutions.com
This post clear every thing about PM VISIT with stock market effect.
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